Student borrowers get a break

Published 4:00 am, Tuesday, May 17, 2005

The Department of Education issued a guidance letter on Monday that could potentially save many college students a boatload of money on their student loans. But they'll have to act quickly.

The letter says that students who are still in school and have government- guaranteed Stafford loans from banks or other commercial lenders can lock in today's record-low interest rates by consolidating one or more loans while they are still in school.

The ruling will put students with Stafford loans from banks on a more equal footing with students who have Stafford loans from the government.

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The rate on Stafford loans is reset on July 1 each year. It is tied to the rate on three-month Treasury bills at the last auction in May. The rate on loans for students still in school is expected to jump from 2.77 percent today to between 4.5 and 5 percent on July 1.

Students can lock in today's low rate, rounded up to the nearest eighth, by consolidating one or more variable-rate loans into a fixed-rate loan. But their application will have to be received by the lender by June 30.

Students who have Stafford loans from the government, called direct loans, have always been able to consolidate while they were still enrolled.

But traditionally, students who have Stafford loans from banks and other commercial lenders under the Federal Family Education Loan Programs could not consolidate until they had graduated or were going to school only half time.

Until recently, the discrepancy between the two programs -- which are identical in most other respects -- didn't matter. With interest rates coming down, nobody was in a hurry to consolidate.

But with interest rates expected to rise July 1, the difference started to irritate college-aid administrators like Nancy Coolidge, a coordinator for student financial support with the University of California system in Oakland.

At six UC campuses -- Berkeley, Davis, Irvine, Riverside, Santa Barbara and Santa Cruz -- students participate in the direct-loan program and were able to consolidate at today's low rates while they were still in school.

At three other UC campuses -- San Diego, Los Angeles and San Francisco -- students have access to Stafford loans from banks. They were on the verge of missing out on the chance to consolidate at record-low rates.

"I looked at the money on the line and said, 'This is nuts. There is no policy basis for the differences in these two programs,' " says Coolidge.

Coolidge and others working in financial aid were aware of a potential loophole in the Higher Education Act that might let students consolidate bank loans while still in school.

One part of the law states that, "In order to consolidate, you have to be either in your grace period or in repayment status," says Dan Madzelan, a staff director in the Department of Education.

(After leaving school, students get a six-month grace period before they have to start paying back their student loans.)

Everyone took that to mean a student couldn't consolidate until leaving school.

But another part of the act said the repayment period could begin before the grace period ends "if the borrower asks, and the lender agrees, to a repayment schedule that starts earlier," says Madzelan.

Of course few students would actually want to repay their loans while they were still in school, but federal law also allows students who have started repaying to defer payments if they are in school. This is mainly designed for students who leave college, start paying off their loans, then go back to school.

About two months ago, Coolidge starting urging UC students with Stafford loans from banks -- especially graduate students with big balances -- to start repaying them so they could consolidate their loans while still in school and before the June 30 deadline. At the same time, they asked to be put in deferment, so they didn't have to make any payments.

Some large lenders -- including Chela, Sallie Mae, Nelnet and Bank of America -- agreed to the plan, "but they weren't going to publicize it," says Coolidge.

There was some concern that the plan wouldn't pass muster with the Department of Education. In late March, college-aid administrators and lenders began pressuring the department to rule on the scheme.

On Monday, it gave lenders and borrowers the green light.

Many schools and lenders are updating their Web sites with the new rules. Bank of America plans to announce the change in a statement stuffer.

Students with large balances can save a lot by acting quickly.

Coolidge estimates that by locking in today's rate on a consolidation loan -- 2.875 percent -- a second-year grad student with $37,000 in debt would pay $9,778 less over 25 years than if he waited until July 1 or later and locked in at 4.5 percent (a conservative estimate of what the rate might be).

The rate on consolidation loans is the weighted average of all loans outstanding. If a student has loans only from 1998 or later and has never consolidated before, the rate on his consolidation loan will be the rate for students in school, grace or deferment (2.77 percent) or students in repayment (3.37 percent) rounded up to the nearest one-eighth percentage point.

There is a small price to pay for consolidating bank loans while still in school: Students give up their six-month grace period. Once they leave school, repayment must begin immediately. (Students with direct loans don't lose their grace period.)

This could be a drawback for students who leave school without a job, but Kathy Cannon, a senior vice president for student banking with BofA, points out that students who are unemployed can apply for a temporary deferment on their payments.

Students who are thinking of consolidating should contact their lenders as soon as possible and ask to be put in early repayment and to get an in- school deferment.

Students who have only one lender must give that lender the first chance to consolidate their loans. Students who have more than one lender may consolidate with an existing lender or choose a new one.

The department's decision is good for existing borrowers, but Lief fears it could make less money available for loans in the future.

"This is going to be a very expensive enterprise," he says. That's because, if interest rates go up, lenders who have made fixed-rate consolidation loans get a subsidy from the government equal to the difference between the fixed rate and a new, higher rate.

"Since we are in a miserable economic cycle and people in Washington are looking for ways to reduce entitlement spending, increased expenditures for this could result in future students not having everything available that former students will have had," says Lief.